Banish unicorns from the pension funds

While the pundits are preoccupied with the fallout of Detroit's bankruptcy, precipitated in part by its huge pension obligations, many more Americans approaching retirement face huge challenges.

In the most recent national Survey of Consumer Finances, the median household near the end of working age had a retirement account balance of only $120,000. Accordingly, the percentage of households at risk in the National Retirement Risk Index has risen from 44 percent to 53 percent in just three years, with the greatest increase occurring among middle-income families.

The Natixis Global Retirement Index underscores the need to improve elderly citizens' livelihoods. This gauge of retirees' well-being in 150 countries ranks the United States 19th on quality of life in retirement, trailing Costa Rica and Belize, among others.

Overall, the U.S. is also well behind Japan, an economic basket case for 20-odd years now, whose retirement system is a ticking time bomb that will set off a worldwide financial tsunami.

These harsh realities appear to be dawning on many Americans. In the 2013 Retirement Confidence Survey, the percentage of workers expressing some degree of confidence about having enough money for a comfortable retirement remained at the record lows of 2011, with 49 percent uncertain about their future. Measures of confidence in the affordability of various aspects of retirement sustained sharp declines — and not just health and elder care. Sixteen percent of respondents were not at all confident about meeting their basic expenses.

Today state-sponsored public pension plans are saddled with huge structural deficits, which have precipitated enduring fiscal malaise in places such as California, Wisconsin, Puerto Rico, Rhode Island and, the worst of them all, Illinois, whose main city, Chicago, is treading close behind in Detroit's footsteps.

Many will be quick to cast the blame on Wall Street. After all, most middle-income Americans rely on their home equity and 401(k)/IRA accounts to maintain their standard of living in retirement — assets acutely affected by the financial crisis. But the responsibility ultimately lies with regulators and the politicians who appoint them.

Retirement liabilities are at the cutting edge of accounting voodoo; taxpayers and retirees are the sacrificial offerings. Decades of lax enforcement and flawed actuarial practices allowed corporations to sweep large parts of their labor costs under the rug of deferred pension obligations. Promises for retirement benefits were discounted at high rates of return inspired by frothy asset markets; big businesses reported record profits, triggering even frothier stock valuations and higher expectations of asset returns in an echo chamber of fervid delusions. Public pensions are on a similar path today.

In 2009 and 2011, the commonwealth passed reforms that bear a stark resemblance to what happened with corporate defined benefit plans: Regulators gradually imposed ever stronger controls on leverage (i.e., funding levels) and riskiness, but made little effort to curb overheads.

They also pushed the funding schedule out to 2040, adding billions to the required payments.

Massachusetts can no longer rely on financial shenanigans to keep the status quo intact. Rather, we must ask harder questions: Does the commonwealth really need 105 retirement boards with over 500 board members and hundreds more staff? Does anyone genuinely believe that many of the teachers and firefighters on the retirement boards are qualified to make good investment decisions, even after the state mandated minimal education requirements for board members?

The savings from administrative consolidation will be significant, but they pale in comparison to the hundreds of millions of dollars in management and consulting fees dished out annually by the retirement boards.

Data spanning almost three decades indicate that employing more consultants and investment managers does not improve returns sufficiently to justify the cost. A retirement system with over $70 billion in assets can hardly find enough lucrative investment opportunities to outperform the market on an ongoing basis and offset the costs associated with such active management.

The lunatic investment expenses that come out of our pockets only bankroll the running of complex financial models as detached from reality as their inventors — chasing, and often seeing, unicorns in the asset markets.

To paraphrase a famed Hollywood actor-turned-president, the commonwealth of Massachusetts has no business subsidizing intellectual curiosity. If we are to reform and secure benefits, we need to extinguish the black hole of fees and expenses that is devouring them.